Page last updated at 00:17 GMT, Tuesday, 23 December 2008

Profiting from the poor

By Katie Hunt
Business reporter, BBC News

Philippine tuctuc driver and microloan borrower
Small loans can help lift people out of poverty.

Wall Street bankers and London fund managers have little in common with Mongolian craftsmen and Philippine tuk-tuk drivers.

But the world of high finance is beginning to take an interest in the lives of those at the bottom of the economic heap.

Microfinance - making tiny loans to the very poor - is increasingly viewed as an investment opportunity and not just a way to fight poverty.

"Its potential as an asset class is colossal," says Jack Lowe, a former businessman, who now works for Blue Orchard, a Geneva-based company that manages microfinance investments.

Investing in microfinance is also regarded a bright spot in the current gloom engulfing the financial world.

But critics say that seeking rich profits for investors and lifting people out of poverty are not always compatible.

And the rush to invest in the sector has sparked concern that microfinance may face its own sub-prime crisis.

Business not charity

Microfinance dates back to the 1970s, when Muhammad Yunus, the founder of Grameen Bank in Bangladesh, began lending to the poor because no one else would.

What is microfinance?
Small loans around $100
Used to start and expand small businesses
Borrowers usually unable to get credit elsewhere
Providers range from charities to small commercial banks

The phenomenon has spread worldwide and these days some 10,000 organisations, both charities and for-profit companies, are making small loans - typically about $100.

Rates of interest are usually quite high, but allow access to credit in places where people cannot readily obtain bank loans.

The hope is that the entrepreneurs, often women, use the loans to start and grow businesses, allowing them to better provide for their families.

Often poorly educated and in precarious circumstances, the borrowers are surprisingly dependable, with repayment rates of more than 95%.

"It's safe, with no default record so far," says Mr Lowe.

Industry estimates suggest that $25bn has so far been lent to about 20 million people, but demand could be as much as $250bn.

'Double bottomline'

Since 2005, the Co-operative Bank has lent about $7m to two funds that back microfinance providers and has been pleased with their performance so far.

Jack Lowe
Its potential as an asset class is colossal
Jack Lowe, Blue Orchard

"We're a socially minded bank and it's a good asset class if you are a double bottomline investor like us," says Richard Wilcox, head of structured and asset finance at the bank. "You want a commercial and social return."

Mr Wilcox is confident that the industry will perform well during the economic downturn and his bank is planning to increase its investments in microfinance.

"To a certain extent, the client that they serve is insulated from the global economy," he says. "People still require a cobbler or a rickshaw driver."

Many investors share Mr Wilcox's view. A recent conference on the industry held in the heart of London's financial district attracted dozens of smartly-suited fund managers, bankers and lawyers.


The flood of investor money into microfinance has raised concerns that some aggressive players are taking advantage of poor people with high interest rates and misleading credit offers.

Tumenulzi, musical instrument maker, Mongolia
Borrowers are reliable despite their often precarious circumstances.

A lot of the industry is losing its focus on poverty alleviation, says Peter Ryan, founder of the Microloan Foundation, a charity that makes loans in Malawi and Zambia.

He says the for-profit loan providers target the more affluent end of the market and do not offer the business training that his organisation provides.

Their loans "go to salaried employees for consumption purposes, to buy a fridge or a bicycle", he says.

"The true social mission is to encourage people who have got nothing to develop a business to get them off the grass floor."


Kate McKee, senior policy advisor at the World Bank's Consultative Group to Assist the Poor, says there is little evidence of significant over-indebtedness, but warns the industry must be cautious about expanding too quickly as money pours in.

Grameen Bank director and Nobel award winner Muhammad Yunus
Muhammad Yunus won a Nobel prize for pioneering microfinance.

She says strong investor interest in the US sub-prime mortgage market created incentives for unsustainable growth and aggressive lending and the microfinance industry must guard against repeating the same pattern.

"We should draw the right lessons from the sub-prime debacle," she says.

"Focusing on financial services that truly benefit clients and realistic growth plans will produce the best value for microfinance providers and investors."

Mr Yunus, who won a Nobel prize for his role in pioneering microfinance, has also expressed alarm at the direction the industry is taking.

"Microfinance emerged as a struggle against loan sharks, so we don't want to see loan sharks created in the name of microcredit," he told BusinessWeek earlier this year.

Broader reach

But Mr Lowe at Blue Orchard dismisses fears that too much commercialism will ruin the microfinance industry.

He says that capital attracted by the good returns will broaden microfinance's reach and make it more self sustaining.

"We see no contradiction between running an activity like a business and achieving a social impact," he says.

And with the reputation of the financial industry at rock bottom and few other investments looking attractive in the current climate, it's a safe bet that microfinance's appeal as an asset can only increase.

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